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Should I or shouldn’t I?

Should I or shouldn’t I?

QR National is the second biggest float in Australia’s history and if I, as a value investor, am to be focused on extraordinary businesses, bought at discounts to intrinsic value, then the second biggest float ever deserves some of my attention.

But is QR National an extraordinary business? And is it available at a discount to its intrinsic value? They are the questions I need to answer.

QR Limited reported a loss of $37 million in 2010 (The Prospectus Appendix reports the continuing operations of QR Limited lost $37 million in 2010). A company-wide restructure, combined with customers rolling off old contracts and onto new, more commercial ones, as well as continued growth in coal haulage volumes however, is expected to result in a profit of $369 million in 2012 (and possibly much higher beyond that).

QR National will start its listed life with a balance sheet that has about $6.8 billion of equity. If QR National hits its targeted profits and pays its estimated dividends over the next 18 months, that equity will grow to $7.3 billion (I have excluded the impact on equity of the proposed dividend reinvestment plan). And if QR National hits its 2012 profit forecast, return on average equity will reach 5.1 per cent.

(POSTSCRIPT;  Much is being made of the profits beyond 2012 and the return on the $3 billion invested.  I had the opportunity to discuss this with L.Hockridge and he pointed to the prospectus forecast for an EBITDA run rate of $170-$190 million.  Aside from the fat that EBITDA is nonsense the NPAT return on capital at maximum capacity will be about 6%.  I talk about this below so I am not too worried about using the 2012 for a few years beyond it.  In any event if 2015 and beyond is where the rewards are; why the rush to invest today?)

Given that I can invest in companies generating 40%, 50%, 60% even 80% returns on equity, should I consider a return that is less than that which cash in the bank generates?

Because the dividend yield is so miserly (and because of negative cash flow after capital expenditure, those dividends are effectively funded out of borrowings) the company is being pitched as a growth stock and growth story.  Growth in coal volumes transported is the validation for the claim.  But when a company generates a 5% return on the profits they keep, you don’t want it to grow.  It is better they hand all the profits back to you so that you can put the money in the bank and get a higher and safer return.  Of course they can’t hand the profits back to you because the cash flow won’t support it for reasons I explain next.

QR National is a capital intensive business and even before dividends are paid, the cash flow will be negative. Between 2008 and 2012 (5 years) QR National will have expended $7.2 billion on ‘capex’ and the company will need to borrow $1.5 billion in the next few years (the prespectus explains it will draw on over $2 billion). This will partially cover the gap between the capex and the cash form operations of $3.4 billion.  The returns the company will be aiming for on this debt funding could be nine per cent or more, but my estimate is that the $170-$190 million in EBITDA from its GAPE project disclosed in the prospectus will be whittled down considerably by depreciation, interest and tax, such that the additional contribution to return on equity of the whole group may not be so significant.

As an aside the prospectus spends a great deal of time focusing on EBITDA (earnings before interest, tax, depreciation and amortisation) but as Charlie Munger once observed, whats the point of looking at “earnings before costs”? And as Buffett noted, the “tooth fairy” doesn’t pay for these things.  Depreciation is a very real expense even though many finance professionals treat it as a non cash accounting item.  In reality when depreciation is based on the historical cost of an item, it will under-provide for the true cost of maintaining and ultimately replacing that item.  This is because the depreciation is based on the purchase price of the item many years ago, but maintaining and replacing it will suffer the impact of inflation.  Thinking about it another way; imagine employing a thousand people for ten years but paying for them upfront and expensing the cost over ten years – would you then say the item is non cash and can be ignored?  The real cost of employing these people will be higher than the depreciation suggests – they will demand salary increases.  Looking at earnings before real costs is nonsense.  Buffett’s advice from his 1989 letter to Berkshire Shareholders is even less accommodating: “Whenever an investment banker starts talking about EBDIT – or whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditures – zip up your wallet.”

One other point: it appears to me that forecast profits (and by inference the 2012 Return on equity of circa 5%), may be boosted by some permitted accounting tricks.  The future profits may be boosted by the capitalisation of interest on debt used to finance assets under construction.  In other words not all of the interest expense in 2012 is flowing through the forecast profit and loss statement.  Some of it will be capitalised (converted to an asset on the balance sheet).  Telstra has done this with software development expenses and the end result is a profit figure that looks better than economic reality.  For QR National it means that $369 million profit reflects accounting reality rather than economic reality.

I appreciate two things about this float. First, some of the smartest operators and management in the country are now driving it and as they point out, quite rightly, prospectus requirements limit their ability to discuss what happens beyond 2012 (but beyond 2012 anything can change, even management themselves). If however, it is the case that returns on equity will creep towards double digits after 2012, then I must ask myself if there is there any urgency to buy today?

The risk of course is the cost associated with paying a higher price for the shares at some future date when the wonderful performance is confirmed. The second thing I appreciate is that I cannot predict what the share price will do. The vendors and their advisors are pulling out every device designed to support the price of the shares after the float. There is the loyalty bonus that incentivises retail investors not to sell until December next year, and there’s the greenshoe permit that allows the managers of the float to step in and buy shares in the aftermarket. The share price may very well perform brilliantly. I am the first to admit that I am no good at predicting what the shares will do.  That is the main reason why I always say you must seek and take personal professional advice. Your adviser is the only person who understands whether QR National or any company and their shares are suitable for you.

I estimate QR National’s shares have a 2012 intrinsic value of between $1.09 and $1.48, but thats in 18 months time. Given there will be 2.44 billion shares on issue, the intrinsic value of the whole business is about $3.7 billion in 2012. The intrinsic value is necessarily less than the equity or book value on the balance sheet because the equity is forecast to produce a lower return than that which I require from a business. The vendors want you today to pay up to double the 2012 intrinsic value ($2.40-$2.80 per share – loyalty bonus and Queensland resident bonus excluded).

I may indeed miss out on some gains if I don’t participate in the float, and I may miss out on very substantial gains. Of course there is the risk of loss too if I do participate. While I might be ok with either scenario, you may not be and so YOU MUST SEEK AND TAKE PERSONAL PROFESSIONAL ADVICE. My comments are general in nature and I have not taken into account anything about you or your financial needs and circumstances. If you want advice about what to do regarding the QR National float, speak to your advisor and if you haven’t got one, seek one out BEFORE doing or not doing anything.

Postscript:  as one of my friends, Chris  – also a fund manager – noted this morning:  “I haven’t looked at the detail yet, but thought it was worth pointing out that the EV/EBITDA multiples they’re using might be a touch disingenuous.  QR are using FY12 earnings on today’s balance sheet (i.e. current net debt of $500 million) despite the fact that they’ll have to drw down on at least $1.5 billion of further debt to generate those earnings.  Essentially you might like to have someone check if they might be using today’s balance sheet and tomorrow’s earnings to lower the multiple.”

On a more navel gazing note…

Short-term price direction is not the trigger for a change of heart towards a company. Indeed, a falling price for an A1 business generally represents an opportunity. Sometimes however the nature of price changes has me sitting up and taking notice – being alert rather than alarmed.

Currently, JB Hi-Fi’s share price has been heading in the opposite direction to that of most of the A1 companies that I am following. Such determined selling has often been the precursor to an announcement. Let me make it clear that other than knowing JBH will hold its AGM tomorrow in Melbourne, I don’t know whether an announcement, for example a trading update, will be forthcoming or not. The rather unidirectional nature of the price changes however, often bodes poorly for the contents of any announcement. Keep a watchful eye therefore on JB Hi-Fi.

I found at my recent visits to a handful of JBH stores that they were busier than ever. But the recent share price changes suggests someone is nervous.

The only subsequent thought I have had is that the high Australian dollar has resulted in price deflation, which JB Hi-Fi’s competitors will take advantage of and the company will have to respond to by lowering prices, putting pressure on gross margins. JB Hi-Fi remains at a discount to my current estimates of intrinsic value and as I just mentioned, I generally take advantage of the market and its Wallet rather than listen to its Wisdom.

Keep an eye on JBH and any news from tomorrow’s AGM in Melbourne particularly about margins, deflation and the Aussie dollar at 11.30am.

Posted by Roger Montgomery, 12 October 2010.

Postscript #2:  JBH AGM notes.  first quarter trading has improved.  Total store sales are up 12.2% but behind BUDGET (not last year comprables) by 5%.  JBH expects to make it up over CHristmas but evidently they didn’t mention the previous guidance of 17% growth in sales (perhaps this IS budget).  Store roll out is on track and 18 additional stores are expected to be opened in the current financial year.  They DID say that they are well placed to maintain margins despite discounting.  Newspapers this morning point to a raft of new games to be released (JBH is the second biggest retailer of computer games) for Christmas.


Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Roger and everybody,

    As a new but very enthusiastic value investor I am intrigued by the current price of K2 Asset Management. Its ROE is over 100% and it has no debt. It has about $900m of funds under management and an excellent track record of ROE since listing about 3 years ago. Being a (hedge?) fund manager it would appear to be in a good sector given the predicted return of cash that is “sitting on the sidelines” into equity markets.

    I heard one counter argument suggesting that the traditional fund management business is under threat from the growing popularity of self-manged super funds, but surely this would not have a drastic effect on the industry as a whole. KAM in particular seems to adopt a more dynamic and flexible approach to its investment, with the ability to hold up to 100% cash or equities, as well as taking both long and short positions (unlike value investors). I get a conservative IV at $1.50. With its current price at 75c I can’t find many reasons to not buy.

    Others thoughts appreciated

  2. Roger,

    Been very busy with work, amused by the comments made concerning this float.
    I have a solution for such duds launched by Govts in trouble. For the first 5 – 8 years the Politicians Superannuation should always be the main investor of such floats especially where they are trying to get the Moms & Dads involved. After that period they could allowed to sell down.

  3. I was interested to note that Sally Macdonald sold additional shares as per the announcement 22/10/10.

    Now herein lies the issue in my opinion.
    If the estimation of intrinsic value is derived from ROE, and ROE is derived from profit, then profit is a major catalyst.

    Now anyone with experience in actually opperating a business will quickly recognise that businesses are ORGANIC. They are constantly adapting to changing circumstances.

    And who better to know the intimate details of the business but the CEO.

    Rogers work on this blog is fantastic. Its provided me with another ‘link’ in my investment framework.

    However like Roger suggests, i will not be blindley following any intrinsic value estimate based on historical data and analysts forecasts.

    To me the CEO consistently selling is a major warning (this is no longer a case of a single sell trade, but a number of sales over a period).

    I missed the opportunity to get on board with oroton at much lower prices, i definately wont be getting on board at anything like current prices with the CEO selling.

  4. I AM a licensed financial adviser who gives PROFESSIONAL ADVICE and like you Roger will not be participating in the folly of this one rather profiting later on from others mistakes.

    The whole process of ‘book-builds’ should not be reviewed and rules changed as it allows intelligent advisers and investors like us to make sustainable prudent long-term returns for people who make the same mistakes time and time again. The type of people who know the price of everything and the value of nothing, those that eventually ‘give up’ on share investing because it’s “all too hard” and will have long deserted QRN because the excitement and hype has gone.


  5. I understand Zara for Oz kicks off in 2011 @ Westfield Bondi. From a family member who was recently in Europe, Zara produces a great product and is well priced. Target market is 18 – 45 yo + kids.

    Note sure how it would compete with SFH brands though – more upmarket than Millers or Katies and didn’t they see any lingerie.

    Might organise a field trip to all the lingerie stores here in Melb to check out La Senza’s competition – any starters?

  6. Hi Roger and esteemed members of the High ROE appreciation Society.

    Let us recite the ancient chant and give thanks to those who have come before us….
    “Margin of Safety, Margin Of Safety, Margin of Safety”

    Out of curiosity i decided to have a look at James Packer channeling Kerry Stokes gobbling up a large interest in Ten.

    This is not a company i would be interested in and i don’t think there is really a competitive advantage at the moment.

    From my calculation the $1.50 he has paid for his poisiton is below my estimated IV based on the results announced today. With a RR of 12% and selected ROE of 17.5% i got a value of $1.70. Which makes it seem like a smart move if you just look at that year.

    However going by the comsec forecasts and some recent rumours i read of him pushing for a 100% POR when he inevitably gets his board seats the future values look a bit different. I decided to use the 100% POR as it does seem to be something the packers favour, they currently do the same with Crown to my knowledge.

    I have from the forecast EPS on Comsec came to the conclusion that analysts expect the ROE in future years to decline in both 2011 and 2012.

    I get forecast IV’s of $0.90 (RR 12% ROE 12.5%) in 2011 and $0.72 in 2012 (RR 12% ROE 10%).

    As mentioned all with a 100% POR

    If i keep exactly to the forecast figures in Comsec including DPS i get a slightly higher values of $0.98 and $0.76.

    Looks like James has some work on his hands as he will need to dramatically change the profitability of the company for it to turn out well. He could probably do it and it will be interesting but another story i am willing to just sit on the sidelines and watch rather than take part in.

    Enjoy your day everyone, i’m might avoid Park Street for a while.

  7. Hi guys,

    I thought I would post WB’s comments about capital intensive businesses from his 2009 letter to shareholders.

    “In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite
    willing to enter businesses that regularly require large capital expenditures. We expect only that these businesses
    have reasonable expectations of earning decent returns on the incremental sums they invest. If our expectations are met – and we believe that they will be – Berkshire’s ever-growing collection of good to great businesses should produce above-average, though certainly not spectacular, returns in the decades ahead.”

    The shear size of BH is making it harder and harder to achieve the returns he has achived in the earlier years. There is just no See’s Candy like businesses lying around at the size that would make a meaning difference to BH’s overall return to shareholders.

    Personally I don’t have WB’s problem and never will so I will look for the See’s Candies of the world rather than the Burlington Northerns

    Hope this helps guys

  8. Dear All,
    I am not sure I am posting on the right place and I am wondering if people searching for the ten bagger businesses would be interested in valuing “Market performance” but I would like to just publicly compare my first valuations on LIC’s.
    CYE, EqPS, PYE, NPAT, PO (payout), ROE, RR, IV
    (ARG) 3228.1, 5.32, 2894.6, 153.9, 76.5%, 5%, 10%, 2.39

    (CTN) 182, 1.21, 153.4, 18.3, 12.8%, 10.9%, 11%, 1.03

    Am I being too harsh on Roger’s A2 Argo? Anyone out there with an opinion on LIC’s?
    Matty on the path to Investing enlightenment.

    • Hi Matty,

      I have always found it difficult valuing LIC’s using the ROE method.

      to really get it right you need to value all the businesses that they own then add them up. But the maths need doing every day as they are constantly buying and/or selling and unless you have inside info you really don’t get the full portfolio anyway.

      LIC’s are basically listed managed funds and most people are here because they want to do it themselves.

      May I humbly suggest that you go and get the list of the top holdings of these funds and value those companies. Then if you find something you like then invest in that.

      PS I just had a quick glance at CTN’s top holdings and big shiver went up my convervative spine.

      Hope this helps

  9. Hey guys,
    Bit off topic, but related to share offerings. Intersting news this morning with announcement of Tabcorp demerger and capital raising. I remember some prediction of this in Fairfax media following recent results and not surprising given the deiffering results of its divisions and also impending loss of licenses. Interested in people’s thoughts about the proposed share offer price of $6.25. I understand it isn’t an A1, but i’ve had this stock for a while and actually was about to off load it as thought it was above value. The $6.25 is consistent with my 2011 valuation (maybe someone on the board has read VALUABLE). Also made me think about the section in the book about increasing value with buy-backs of shares at discounts to IV or allocating shares at premiums to value. Thoughts?

    • Hi Matt,

      I used to be in this company as well but sold off for a few different reasons.

      My conservative side tends to get a bit nervous with what seems a complicated deal/change. Can’t give much info on the price. Was part of the PBL/Crown demerger and think i came off worse then.

      I am guessing this is partly done to try and woo potential suitors for the businesses in a takeover but the limit on anyone not being able to own 10% of the shares will make it a bit more difficult for this to eventuate as a company can’t build up as big of a holding as they might like before launching the bid at a premium.

      I am going to keep an eye on the split casino business, the refurb program i believe whilst costly will result in better results and having Larry Mullin calling the shots is a huge plus as he knows the casino game as good as most. The downside is that i think the company will have quite a bit of debt on its balance sheet from the reports i have read so far. As mentioned i’ll keep my eye on it and if it starts fitting into my criteria and can get at a great price i would be jumping in albeit with a 11-12% RR.

      The wagering business should be interesting story to watch in the same mould as watching a house on an eroding coastline and wondering whether it will have the ground collapse from underneath it or not. It is still very uncertain at the moment what parts of this business might still be around once demerged. I expect them to be awarded again with the licenses it could lose however this is no certainty and i don’t like uncertainty in a company. My thoughts are however that this side would be the first to be taken over if any are. I think a lot of overseas wagering companies want to get into australia (look at the amount of time paddy power, ladbrokes and intralot have apllied for government licensing proposals) and then you have Tattersalls. A takeover by Tatts will create a monolpoly in that industry which might cause it to be blocked but the potential benefits a monopoly could offer to customers might cause them to ok (larger betting pools is one such example).

      • Hi ANdrew and Matt,

        Buffett has been selling Moody’s because it has lost some of its competitive advantage (its moat is eroding). Its the same thing here – arguably sensible to cast it adrift.

      • I agree Roger, I see potential in Star Cty but your right their competitive advantage is slowly going.

        Their are too many options for the wagering side with all the Darwin bookies able to offer more attractive odds. Keno i would see as a non-core asset. It could go and i don’t think people would really notice as their is no big demand for that product. The pokies license was the best asset on the wagering side and they have lost that.

        On the casino end, i have always split that up into two businesses. The Worldwide and Local Markets. The worldwide being the big money players or whales (whatever you want to call them).

        Tabcorp can’t compete with Crown let alone the other international businesses like the MGM’s, Harrahs, Wynns and Sands for the world wide big money market. They have no compeitive advantage in that area.

        You could say they have a competitive advantage in the retail market as they are the only casino’s in that market. However on further look, their casinos are in NSW and QLD where anyone can find a local pub closer to their home where they can play the EGM’s so unlike Burswood in Perth their is no real draw from this area.

        The closest thing to a competitive advantage is the table games as they can only be played in the casinos, however most big clubs now have blackjack and roulette multi terminal electronic games and this is expected to increase slowly eroding the moat in this area. Casino’s make little to no money on poker. So if their is no current competitive advantage into the core games/products that casino’s offer then where else can it be?

        As mentioned i think the project star program can make a big difference in helping it to re-establish an advantage however i will wait for this to be proven before i even think about hoping back on board.

        My opinion, and please seek your own advice as Roger would say i am but a gumble clerical employee, is that if i was a Tabcorp shareholder i would sell my stake when it starts trading again, invest it into an affordable A1 and wait to see what happens with Tabcorp if i must. I also believe there is a risk of a new round of capital raisings after the demerger (especially the roumered debt-laden casino business) but that is just a gut feeling.

  10. Hi,

    I am trying to forecast the IV for 2011. I seem to have all the other steps under control, however I am not sure what NPAT and Equity balances to use to calculate the ROE. Do I just use the 2010 NPAT and the 2010 ending equity (as this is the opening equity for 2011)?

    Any help would be great.

  11. Hi Cam/ Roger/Ken
    I get the similar to Ken, but understand that everyone will come up with differences.
    My concern would be, will WOW and Bunnings go head to head for some of this business.

  12. Roger,
    Any thoughts, given the appreciation of the aussie dollar of listed investment companies that focus on international stocks, that may be trading at a discount to thier underlying portfolio value, ( eg TGG). Or perhaps you may suggest other means (ETF’s etc) of gaining exposure to international equities.


  13. Hi Roger,

    Buffett often talks about his mistakes and he breaks these in to two types, the errors of commission and the errors of omission.

    Those of commission are plain to see, they are losses on paper where he bought high and sold low (or is carrying at a loss with little chance of making good).

    Those of omission are the more interesting and in his words “the biggest losses are those of omission which regular accounting methods do not detect”. Here he is referring to the opportunities where he evaluated a company, saw the potential for gain but for whatever reason did not pursue the opportunity and then spent the years following ruminating on why he made the wrong choice by not buying it. In some cases he instead bought something else which turned out to be inferior! Regular accounting does not pick up this kind of investment mistake.

    Obviously it isn’t a terrible problem to have, he is the best investor in history and his concern is that if he could have just made a few different decisions he could have been a better best investor in history!

    My question is – you have been value investing for many years, and certainly many more than I have, would you be willing to share some of your mistakes? Whether they be of omission or commission, I think they would be value.able. If you could share what you learnt and why you think you made the mistake(s) I think that would be a very interesting topic for a future blog post.

    By the way, I don’t think that QR will be an error of omission!


    • Hi Matthew,

      regarding your request for a list of mistakes – all but one fall into the error of omission. I will indeed take up your invitation and put together a future blog post on the subject.

  14. Hi Roger,

    You are reading into JBH share price too much.

    Reality is that resources stocks are in demand and therefore retailers, etc. are being neglected to an extent.

  15. Another amazing post!

    I love reading your stuff.

    I know you have something special planned for my copy :D

    I’ll be ordering very soon. Soooo excited!!!

    As I plan to do my Kaplan financial licence you always excite me about shares.

    • Great to hear Matthew,

      Thanks for your comments regarding the blog. I look forward to hearing your thoughts about the book and don’t forget to seek and take personal professional advice. Don’t miss out on the next print run if you are keen to read the book.

  16. Hi Roger,

    Thought i would just ask you quickly here. Was going over some old blogs and saw the blog where you posted the exercise where you hid some details and we worked the valuations out. You later posted the answers so that we can see how we went.

    For WOW you had a number of shares of 1223.6. I am wondering if this is your correct figure or if it is a typo as i have 1226.3. Same numbers but different order. Not much of a difference but still a difference in the equity.

    Basically just wanted to see if i was looking at the right figure or if you are getting your # of shares figure for WOW from a different area.

  17. Hi Roger,

    Just watched last night’s Switzer. Had to chuckle. So did that broker call your fundamentals hocus pocus, then counter you along the lines, “surely the government wouldn’t float a dud”?


  18. Re JB Hi Fi sales outlook. JB should fly as there is so much must have new technology in the pipe line as well as the steady diet of games and dvds etc. so there should be plenty of sales in this strong economy. I feel their cheap and cheerful discount look does a dis service for the introduction of the next wave of new technology,ipads,digital radios, blue ray and other upgrade/premium price items. At present these are piled in with all
    the other stuff crying out discount! discount! Maybe it is time for a JB HI FI premium store concept or are the current management still wedded to the hand painted price card look for everything?

    • Hi Andrew I think part of the competitive advantage of JBs are those yellow hand painted signs and those very low prices. If they went off and change direction to more upmarket they could alienate the customers that have made them the high ROE powerhouse they already are. If it’s not broke don’t fix it.

  19. Hi Roger,

    Just back from the local shopping centre. It’s one location, at one point in time, and nothing more than my observations:

    1. TRS – checkouts were ringing non-stop.

    2. New large shop being outfitted. I overheard someone say JBH.

    3. Clothing boutiques (including outlets of businesses discussed on your blog) – shoppers sparse at best.


      • Hello Roger et all,
        Thanks for great book (awaiting ValueAble for Dummies as per Switzer:-) and wonderful insights. Being a newbie poster but long term lurker here, I am interested in your thoughts = MQR for TRS as I seem to struggle in obtaining a ‘reasonable’ IV – surely it’s IV has to be nearer the current share prize $ 18.22 than the IV of $13.50 I manage to squeeze out from my meagre attempts at applying my new found knowledge.

      • Hi Erika,

        Welcome to blogging! I am delighted you have written. Each time you visit the site be sure you hit refresh and empty your cache so that you can see the latest comments. In those comments you would find that each of the inputs can differ – some because the source (eg. comsec, huntleys/morningstar, etrade, annual report) presents numbers that vary and some because the assumptions about the future are different. I see you have been reading a great deal here, so do as others have and submit the inputs you have used for your valuation and I have every confidence that you will get a great response, if not from me then from the many Value.able graduates that also “lurk” here. My estimate of intrinsic value for The Reject shop for this year is $14.31 and $17.10 next year. Seek and take personal professional advice.

      • Hi Ashely – Roger:
        Many thanks for the helpful replies-particularly to Roger for also supplying hints re managing the blog thingie – now if I can only spot the cache to empty it.
        Feeling reassured re my attempt at valuing TRS – although an A2 business I suspect it may be doing better over coming months due to increase in the A$. I chose TRS over JBH thinking that JBH may have more of a struggle to maintain/increase sales as the plasma/gadget/dvd/games market seems exhausted pro temp. How many TVs/Xboxes etc can any one household cope (buy) with? Not to mention the fact that more units need to be sold in order to maintain profit. On the other hand TRS sells everyday items, often cheaper than supermarket prices and with interest rates allegedly on the rise i would think TRS’ profits can only grow. I know both are rolling out more stores.
        So how do people chose one company over another when the fundamentals seem to stack up? Like FGE vs DCG – can’t decide on either as both seem to have great potential although perhaps more upside with FGE ?

      • Hi Erika great post by the way.
        To answer your question “choosing one company over another” it simply comes down to the margin of safety, which one is trading at the greatest discount to it’s intrinsic value. TRS and JBH are both great businesses with consistently growing earnings and high returns on equity and the future looks pretty ok too but from my calculations of intrinsic value only JBH trades at a discount. I have TRS trading at a slight premium and this might because the market agrees with your thinking – we’ve bought all the gadjets we need from JB’s and now let’s head to TRS for some everyday bargains. I’ll choose to own JBH because of the margin of safety and that’s the no.1 determiner in my opinion.

      • Erika,

        Good question regarding preference for one over another when it comes to the likes of FGE and DCG. For me it comes down to looking at the various margins in the business. Gross and net margins vary quite significantly in the engineering services space. Higher margins suggest to me a stronger competitive position. So other things being equal I prefer the outfit with the higher gross and/or net margin as they have a bigger buffer in the event things go bad and/or competition heats up.

        I’d like to hear Rogers view on the variability of margins across the engineering services space and what significance, if any, he reads into this business metric.


      • Hi Erika,

        I agree with Craig M

        But can I suggest the most important thing of all is patience.

        To quote Warren Buffet

        “You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing”

        I have a list of Buffet quotes that I read before I invest and quite often this one stops me from investing.I have found myself wanting to do something.

        I have tried to teach myself that “Don’t do something just because you can”.

        I know with great certainty that extraordinary opportunities will present themselves (after all they allways have in the past) you just have to wait around for them.

        Ie use your lurking skills (nothing wrong with that)

        Hope this helps

      • Hi Erika,

        LOL at cache comment.

        I am an internet gumby and had to google it to find out what everyone was taking about

      • Hi Erika,

        I assume you are looking at 2010 IV so I think your first attempts are just fine.

        I think if you go back and look at the posts around reporting time you will find that Roger now has an A2 on TRS. Down from A1 presumably because to the increase in debt levels.

        When I was first told about ROE investing I used to think surely my valauations are wrong and if I change this variable or that variable I will get a value closer to the current price.

        My thoughts being the market can’t have got it that wrong and I really want to own this business.

        My wallet soon learned that this was a mistake.

        After you have practised and become confident in your valuations you will learn to trust them.

        For what its worth I have TRS 2011 IV at Mid $17 but rising at a good clip if the analysts are correct. The analysts will probably not be right though as they have ROE still rising and it looks like it may have stabilised or worse may be declining.

        A few minor warning bells were sounded in the last set of accounts. Return on capital fell back to 2006 levels. Still a good business though.

        Hope this helps Erika and well would all like to see you post again. We all like to read everyones insights

  20. Roger,
    I would you be interested on your take on Reece at the moment as you have not written about it for some time. With it’s share price as close to intrinsic value as it has been for a while is this probably as good an opportunity as we are likely to see. Also do you have any more concerns regarding CSL as the dollar continues its rise. I know the company is performing well, but from a currency risk could this hurt their overall value.

    • Hi Cami,

      When it comes to curency swings and round-abouts, I don’t worry too much especially since ours is commodity influenced. Some strategists believe that our currency is far overpriced and due for a substantial correction. I don’t speculate about those things so I simply respond conservatively to valuation estimates and demand a larger margin of safety. Regarding Reece, my current estimate of its intrinsic value is $20.80. Seek and take personal professional advice.

    • Cam/Roger,

      You must be using an awfully generous RR% for REH. I can’t get a valuation any higher than $12.73, using a 12%RR. Am I missing something or are you using about 8% ?

      Regards, Ken

  21. Hi Roger

    I know I am preaching to the choir here but in case anyone was even mildly thinking about purchasing QR Rail even if it becomes attractively priced in the future) I offer the following.

    •Since the 1850’s when railways first started operating in this country large scale private railways have never been profitable.

    •The freight rail business only became profitable in this country for private enterprise when the rail operations (above rail assets – eg locomotives and rolling stock) was separated from the below rail operations (track, signalling etc). Essentially, State and National Governments underwrite private freight rail businesses by subsidising the ARTC (Aust. Rail Track Corporation), RailCorp (in NSW) and VicTrack (Vic) and QR Rail in Qld to enable these organisations to provide the track infrastructure for private businesses to operate their trains.

    •But we hear people say there are large scale private operators of track and trains in this country – for example BHP and RIO in the Pilbara. Yes!, this is correct. However, these companies had to build this infrastructure themselves to get their iron ore to port. No other private transport business was willing to do this for them. Hence, the cost of these rail operations are paid for in the price of iron ore and are an operating cost for the mining companies.

    •QR moves a lot of coal. Coal mines open and close over time. There are a lot of branch lines that need to be dig up and rebuilt all the time.

    •QR will be forced by the ACCC to let other operators use its rail lines. Similar issues to what Telstra had.

    •I don’t think the Qld Government will be too keen over the next 5 years to help QR with funds to look after the track infrastructure after they have privatised the network

    On a seperate note, has anyone had a look at the MACA Ltd (contract mining, civil earthworks, crushing and screening and material haulage) float. I am working through the Prospectus now to get an IV and a handle on the strength of contracts. Looks like they do not need any new work to meet forecasts but there are a few contracts coming to an end in the next year. offer price is $1 and webiste is http://www.maca.net.au. There is an article in the Fin review today but is certainly slipping under the radar with the QR buzz!!!

    Great book Roger. Combines the thinking of some great investing minds (Graham, Buffet, Montgomery just roll off the tongue) and relates it wonderfully well to our own minature market here in Australia.


    • Hi Allan,

      Thank you for taking the time to freely contribute your personal insights. As you point out, it doesn’t change my mind (we’re singing from the same Hymn book). And don’t forget very real issue of the Government being both buyer and seller. The size of the company (not withstanding any free float restrictions) will mean it is included in a number of indices and force index funds, huggers and those with tracking error considerations in their investment process to buy the stock. The devices being used to support the price may also prevent the price collapsing and so there may be a premium to the issue price on the float, but this is speculation and fundamentally, it is not justified by the performance of the enterprise. Thank you so very much for your contribution.

      I am looking at MACA’s prospectus as we speak, so will discuss it soon.

    • Allan,

      I stumbled across the MACA prospectus the other day and started having a look through it. You simply cannot underestimate the value of a blog that has really become a chat room of like minded people interested in the art of value investing, and willing to share their insights with others. Because where else could I you go to discuss the IPO of a company that is not considered relevant enough for discussion by the wider Broking industry?

      I digress.

      I’ve not myself started to calculate the IV for MACA quite simply because I’ve not yet fully grasped their business model. A number of points stand out however:

      The existing client base is quite small in number and “mid cap”, so MACA will need to work hard to advertise its presence to the bigger players for more lucrative contracts.

      There’s not enough information in my view, explaining their loyalty contract renewals. For example MND has an extremely high contract retention which is vital for ongoing cash flow. This is not fully explored in the MACA document.

      Lost time for injury is high against the benchmark and I note that a KPI for mangement is to reduce that number down. That existing high figure actually concerns me quite a lot as it can indicate poor corporate OH&S awareness, or potential corner cutting.

      And lastly I’m not sure how I feel about an IPO where mangement are unable to really tell you where the capital raised will actually go, because (quite rightly) in effect they have to put the cart before the horse. By that I mean they have to raise the money, then go out and ask mining companies to accept their tender on the promise that if they do, they’ll go buy the equipment to undertake the work. Bigger companies have fallen victim to that trap and been unable to complete their obligations to the tender they won. It’s a risk that can’t be understated because competition is very tight in this area and there are excellent companies in that space.

      On the upside however, there are several worthy attributes to the company:

      The increase in earnings and NPAT are impressive.
      They are looking to diversify their business activities and (I think) vertically integrate services, which will provide a hedge against some downturn.
      Their cash on hand is okay according to the Prospectus.

      For me the IV would have to look good. And even if it did, the way I view it is that I only have room for ten stocks in my portfolio. Therefore each one of those has to be what I judge to be the absolute best of the best. My test is: Are the fundamentals of this company so compelling that I would replace one of my existing stocks with it?

      If the answer is no then I’ll wait to see some more runs on the board. I may miss out on the start of something special, but if it is, then it will still be special in 12 or 24 months time. so I’ll have a look at it then.

      • Hi Allan,

        Thanks for your very well-considered thoughts about MACA. Bonding usually covers one of the risks you describe and I agree that there’s the hint of ‘me tooism’ here with the share price performances of peers – many of which we have discussed here for some time. Thank you for your kind and encouraging comments and again for taking time to write such a considered comment. My intrinsic value is substantially above $1 (the float price) but again you need to ask; “do I buy the 4th best thing or more of the 1st best?” and then ask if I need any more exposure to this sector. The metrics are more compelling than QR National.

      • Some interesting thoughts Allan and Roger. I’ve managed to trawl through the MACA prospectus to the best of my ability and I too have the offer price substantially below the IV for 2010 and 2011. My calculations came up with $2.06 (2010) and $2.59 (2011) but I am new to these IV calculatiions.

        Of course the sector is not without significant risk as can be seen by Macmahon Holdings – Although they have never been close to achieving a 45%+ ROE like a Forge and by my calulations a MACA. But we are taling about small companies here, not a larger, more stable beast like a MND, MIN etc. But they were small once…

        FGE and MACA are well run businesses and this endorsed by their metrics – What we need to work out is a) their reputation and growth prospects b) what is a feasible margin of safety in light of this. We know there is risk in the sector, that’s a given.

        Just some thoughts for the what’s its worth basket


  22. A good investor once told me:

    There can be a number of reasons for insiders to sell shares, but theres only ever one reason why they are buying them!

    Something to think on.

  23. Hi Roger (and all Value.able appreciators),
    I thank you so much for the book and all your wisdom on this site. Good to see you on the TV tonight.
    I have only been serious about investing in shares for about 12 months. Started off making my money via charting, but now I see the light.
    I thought I had this stuff nailed till I hit FMG and MCE and my results came back as 70% possible return. I know it cant be right as even at RR12 I get IV of $12.41 for 2011 for MCE.
    Maybe Commsec is not very good for source data?
    Also, what books should/could I go onto read from here. I am serious about doing this after making min returns so far of 12.8% (after tax) since June last yr. But it was probably due to luck that I got them.
    Also, I really need to find (read about) getting the source material for future years as I do not like putting much weight in the EPS/DPS predictions on Commsec. Sadly I get lost when I pick up a 300 page annual report, especially if the first qtr of it is “how great mgt is and how they have upped the share price”. I cant see how the income statements etc tell you what to expect for next yr.
    As to QR, I did not value it, but even as a banana-bender, I am not interested (this is only an opinion to anyone who reads this). If you want to own a railroad, there is a great game called Railroad Tycoon, better to blow your cash on that, at least it will still make you happy in a yr or 2.

    • Hi Chris,

      There could be a variety of reasons for any differences in our valuations. Search through the comments on each of the recent posts and you will find quite a lot of discussion about the source of differences in the valuations as well as the efficacy of the data sources themselves (Commsec included). You are not the first person to get lost in an annual report but its made easier if you simply focus on finding the data you need to perform the necessary calculations. Once you have identified the basic data, you need to simply ask whether the figures are a reasonable approximation of the future or whether there are one-offs, for example. Be sure to seek and take personal professional advice of course before engaging in any stock market activity. Thanks also for your thoughts on QR National. I am surprised by the generally negative view everyone has. There have been very few, if any, supporters. I had expected some conjecture.

      • G’day Roger

        “I am surprised by the generally negative view everyone has. There have been very few, if any, supporters. I had expected some conjecture”

        Group think maybe?

        Invert always Invert. (I’m sure you know where that comes from)

        I don’t know the business well enough (or the inclination to research it) to have a crack at a counter argument – What about you?

        I understand the two railways are chalk and cheese but is it also possible that we are missing something beyond the obvious in relation to Buffett’s evolution form shunning capital intensive business to owning Burlington North.?

      • Yes, but Roger, you have changed the angle from which people are viewing things like QR, and from this angle, it doesn’t look too attractive, even before we get into the shenanigans of the promotion of the float.

      • Hi Gavin,

        I agree with many commentators that Warren Buffett is forecasting a future of higher global inflation by buying BNSF, and in that environment he is better off owning assets rather than holding cash.

        Buffett would still prefer to own a business that is not capital intensive and can raise prices at or ahead of the rate of inflation (think See’s). However, with so much cash on the Berkshire balance sheet and with the value erosion that comes with inflation he has decided to take the next best option which is to find a capital intensive business where at least he can get reasonable returns on his invested capital. Similar to his strategy of buying electricity assets.

        Assets bought with today’s money can be more easily paid off and earn a greater return with tomorrow’s inflated money.

        But the difference is that Buffett still bought BNSF at a discount to it’s IV. With all of the above in mind he still didn’t sacrifice Graham’s margin of safety rule to buy BNSF.

        My question then is, can you do the same with QRN?

      • Hi matthew,

        Just another thought when comparing Buffett’s purchase of BNSF and our own QR National. I valued BNSF at $117 or thereabouts so yes he did get a discount to IV but not sure QR National is not available at a discount and there are arguably companies that offer the same inflation protection that are below IV.

    • Chris,

      In order for any of us to help you, we need to know what figures you are using, but my figures for 2010 – as a starting point – are as follows;

      TY EQUITY $59.893M
      LY EQUITY $20.581M
      SHARES 69.964M
      NPAT $18.159M
      DIVIDENDS PAID $2.258M
      ROE% 30% (Note that I calculate this on TY Equity as it has increased so much over LY)
      RR 12%
      IV for 2010 $4.17
      Based upon a 50% increase in NPAT for 2011 I then get an IV of $6.84.

      You might like to compare my 2010 figures to yours to see where the difference is. If you are using the LY Equity figure in your ROE calculation, of course, you will get a much higher ROE% and therefore a much higher IV, but I don’t think that is appropriate when looking forward.

      Hope this is of some help.


      • A 50 % increase in NPAT for MCE is a very conservative estimate given that their Q1 FY 10/11 profit before tax amounts to half of the entire FY 09/10 result. This indicates that they are on their way to double their profit for this FY.

      • Mikael,

        You are quite right of course. I prefer to be conservative, and then also buy at a discount, which puts me in a strong position if the upside potential is achieved, and very little risk if it isn’t.

        Regards, Ken

      • MCE – matrix engineering
        2008/2009 2009/2010 2010/2011 2011/2012
        book $0.410 $0.630 $1.040 $1.420
        Earnings $0.063 $0.260 $0.480 $0.610
        Dividend $0.020 $0.032 $0.140 $0.200
        ROE 15.4% 41.3% 46.2% 43.0%
        payout 31.7% 12.3% 29.2% 32.8%
        RR 12% Value $0.58 $5.66 $9.09 $10.94

      • hi everyone and roger,

        these are my valuations for matrix for next couple of years. I’m using average equity and end of year number of shares. still cheap compared to next year value. Roger, am i close to your calculations? cheers.

        MCE – matrix engineering
        fy09 fy10 fy11 fy12
        book $0.410 $0.630 $1.040 $1.420
        Earnings $0.063 $0.260 $0.480 $0.610
        Dividend $0.020 $0.032 $0.140 $0.200
        ROE 15.4% 41.3% 46.2% 43.0%
        payout 31.7% 12.3% 29.2% 32.8%
        RR 12% $0.58 $5.66 $9.09 $10.94

    • Hi Gavin,

      I starting Inverting “Be part of something Big”

      when I Inverted “P a r t”

      I got “t r a p” and stopped what i was doing immediately

    • Hi Chris I use Beginiing Equity To calc ROE so my MCE figures are below

      Code year BV EPS DPS ROE RR PO IV

      MCE 2011 0.86 44.7 10.5 51.98% 0.15 23.49% 8.60
      MCE 2012 1.20 61.4 14.9 51.08% 0.15 24.27% 11.55
      MCE 2013 1.67 72 18.6 43.19% 0.15 25.83% 11.49

      You have to decide if the analyst forecasts are correct but sometime extraordinary opportunities present themselves

      Hope this helps

  24. Hi Roger and All
    One of the things hurting all retailers at currently is the availability of being able to buy electronics etc direct from USA.
    Previously a lot of items you wished to purchase were rejected for shipping by Amazon etc,this prompted an Aussie to set up a forwarding agency in the USA.
    For a 5% fee plus shipping most items including Apple computers arrive at your door with a 10% to 40% saving thus placing pressure on our retailers to cut margins

    • Thanks William,

      Thats also true with cycling equipment. A website in the UK provides huge savings ( a website in Aussie dollars) along with free shipping globally. Tough for a local bike shop to compete with the chain of a lease preventing pricing flexibility.

  25. Roger mentioned Zara earlier. Does anyone know where the australian license for the Zara brand went. I read a while a go that it was to some company attached to Solomon Lew and there for i thought maybe Premier Investments but that does not seem to be the case. Which i am quite happy about as i am not a big fan of a lot of the brands they own, some are good but others not so much.

    I think Zara will have a huge impact on the Australian retail scene. Not so much on David Jones but definitley some of the more middle range boutiques (witchery etc) and quite possibly Myer as well due tot he type of clothes that Myer stock being more middle range as opposed to luxury (DJ’s).

    • hi Andrew, from my knowledge, Solomon Lew’s son has held the rights for many many years, and had a small distribution from time to time into Myers. they are finally launching their first store in Pitt st mall new westfield mall. I’m originally from Israel and we had Zara their for years, and being a guy who is not big on shopping…i think they have great fashion at good prices!
      i also think the Lew family are naturally born rag traders…so watch out!

  26. Another thing re: QR. I think i read somewhere that as an incentive for retail investors to get on board there is an offer that for every twenty shares or something they will get another 1 after a certain period of time. Sorry for the vague info, i have not been paying much attention to QR.

    If the above is true, where will the shares be coming from and will this in effect just be the equivalent to a capital raising and there for decrease the ROE and there for the valuation further making it a greatly expensive investment.

    • Hi Andrew,

      The loyalty shares you refer to are a bonus share – so they don’t raise any additional capital. One suspects they will come from the vendor rather than dilute the existing shareholders, but I have to have a look. Great question and worth checking.

  27. QR

    The most cursory glance tells you it’s not a quality business. To me that’s the end of the story. No need to price it. I wouldn’t care if it’s cheap. I don’t care if its business will improve in the near term – It will never improve enough to be a quality business.

    Money can be made on the price fluctuations from average companies. In fact they normally have the highest operational and financial leverage to cause market fluctuations. But that mode of investing is not my game.

    My analysis = Low Quality………Next.

  28. Talking to an electronics retailer, he saw price deflation as the biggest problem. “We have to sell twice as much to make our revenue target because prices are half as much.”

    Prices are falling faster than customer expectations for reductions so margins aren’t so much the problem at the moment. Falling prices stimulate demand which gives volume a boost but even so getting the volume to offset the price deflation to achieve revenue targets is tough.

    So what happens next? Dollar stops appreciating and cost reductions slow – customer expectations of reductions won’t evaporate as quickly, putting pressure on margins. Demand boost from falling prices disappears. Demand possibly dampened by tightening monetary policy. Credit creation contracts Employment falls or alternatively maybe terms of trade continue to go through the roof, investment, population and employment all boom. Who knows for sure? Certainly not me.

    None of these macro issues really mean diddly squat to the ‘quality’ of JBH. But it does have an impact on how you should value it. Your numbers should reflect the averages for the whole cycle unless you planning to change your holding based on the cycle itself.

    Extrapolating recent ROE (or using analysts forecast who seem to simply seem extrapolate the recent past) would be too optimistic in my view if you were investing with an eye to a holding period that covered an entire economic cycle. (good times + bad times)

    What is YOUR preferred time frame? That’s probably the most important question to ask yourself when thinking about what ROE is appropriate in calculating YOUR valuation. Using numbers based on current business conditions is probably appropriate if you are a market timer. But a true long term holder of exceptional companies needs to be thinking averages over the entire cycles.

      • Very interesting comment Gavin, and one that i think is very “valuable” to this blog. I have two comments to make on it:
        (a) it just highlights the importance of buying at a substantial discount to intrinsic value. This will reduce the ‘risk’ of the investment.
        (b) i think static ‘buy and hold’ is an inefficient investment strategy. One only ‘buys and holds’ for the duration that an intelligent case can by made to own the stock. If the business suffers a decline in business conditions, this will be reflected in the profits which will be reflected in the ROE which will be reflected in the estimated intrinsic value. Under such conditions the individual investor has to make a decision based on his own personal circumstances whether to continue to hold the stock or not.

  29. Another great article and I completely agree with your thoughts on QR. They may go up but based on values if we were to buy then we would all be reverting back to our speculating as opposed to investing days.

    I am interested in your thoughts on JB Hi Fi. I have read the AGM announcement today and apart from them reporting sales are 5% down on budget and discounting continues, all appears in order with the company. They also note they expect to recover the 5% in the 2nd half.

    I am not seeking your advice but merely believe this is an opportunity to get back into the stock and would appreciate your thoughts.

  30. Thanks,but a ticket on this train is too expensive.What about a Seniors rate? I’m sitting back and waiting for the next train (Pacific National perhaps)after all I want to catch the train,not be run over by it

  31. Roger,

    QR National: the advertising proclaims “Get on board something big”.

    Big, yes it is! Hugely profitable, no it is not. The numbers bear this out.

    The Titanic and Hindenburg were something big and those who got on board sure regretted it.

    Yet both offered all the promises of a new experience!

    I see the parallels. So no thanks, I will decline the offer of a ride on this big one!


  32. Hi Roger, I just want to congratulate you on attracting such excellent commentators to your blog. I follow a number of investor blogs maintained reputable personalities on the world financial scene and have to say that your posts have the most interesting and authentic mix of grass roots insight, peer-to-peer sharing and noteworthy scuttlebutt, by a long shot. Does not surprise me as my experience is that the quality of blog visitors reflect the traits and personality of the blogger.

    • JohnC,

      Thanks for those very kind words. I too am thrilled by the quality of the comments, the very accommodating nature of the contributors and most of all generosity. Thank you again.

  33. Hi Guys,

    To put things in prepective regarding Sally Mcdonald has a large number of options due and perhaps she is just selling down to take up these options.

    jest intended Sally keep up the good work

    After all the MCE boys did something similiar fairly recenly and we did not bat an eye lid at that,

    Still getting less warm on this company but their are other reasons for management selling rather than poor performance

  34. BWT Roger,

    Us Queenslanders are very very disappointed that you are not coming up to our state to do one of your talks.

    All over the country except Qld Tassie and NT

    Has the QR float turned you off us banana benders that badly?

    Qld is not just full of coal trains and beach bums you know.

    Just a tip but we stop pulling people up at the border to inspect their fruit back in the 80s.

    Is this a state of origin thing?


    Hope you can find the time to get up here one day.

    Thanks again for this great forum

    We are all learning every day

  35. Hi Roger
    Using my own filters and taking IV into consideration I have a buy price of $8 for ORL and $19 for JBH. If you set buy prices for your stocks ( yearly?) and ignore the market noise it makes the decisions so much easier. Look at the year high and the year low for each stock you own. Aren’t we as value investors supposed to buy when the price is low instead of dreading that the stock is going to disppear. Stocks with low debt and high ROE are not easily killed, Sure, occasionally we wil lose out, but the main drift is upwards. By the way I have a buy price of $50 for CBA. So I have been buying ORL and waiting on CBA and JBH to fall into the buy zone. I don’t care if Sally is selling stock or Mr Harvey is down on the opposition or the reserve bank is raising interest rates. If the stock drops below my strike price I buy it and if it doesn’t it’s a painful waiting game. As Buffet says the market is a casino for transferring money from the impatient to the patient. I have been trying for 30 years to be the latter. IV calculations have added another string to the bow. By the way long term calculation for the median All Ords 2010 is 7740 so we are all buying severely discounted stock but can’t see it. There has never been a better time to buy stocks in my lifetime. Confidence please value investors.

    • Hi brian how do you come up with this statement?

      “IV calculations have added another string to the bow. By the way long term calculation for the median All Ords 2010 is 7740 so we are all buying severely discounted stock but can’t see it”

      What is the rational behind the calculation to derive 7740.

  36. Hi Roger,

    Great call BTW on the JBH figures,

    My eye however, was drawn the capital management section of the presentation.

    The company is now spitting off more cash than it can reinvest back into the business even at the more elevaled payout ratio of 50%.

    To my mind this hinted at two options

    1) Further Increase the payout ratio (not a big fan of this one)
    2) Undertake a share buyback (yes please at these prices)

    The other thing I noted was this comment

    “The company has been assessing its capital structure to ascertain the right balance between
    financial risk and efficient capital usage.”

    It may be my cautious mind but to me this mean levering up.

    For what it’s worth I hope they buy back their shares with the surplus cash that the business is throwing off but not go into debt to do it.

    Thanks guys love other peoples thoughts on this

    • Hi Ashley,

      I am guessing the board will either think the shares aren’t cheap enough to buy back or won’t run the risk of being seen to buy shares before any possible fall. Another increase in the payout ratio will be a much lower risk option. Be alert for increases in borrowings and or declines in ROE.

      • Hi Brock,

        Don’t underestimate the irrationality of some when it comes to capital management. Allocating capital is a very different skill to running a business and not all managers have it. We will have to wait and see how management respond. Borrowing increases risk, but some see it as a solution to the famed “lazy” balance sheet.

    • G’day Ashley,
      I had similar thoughts about the presentation. It’s certainly very easy to read too much into it, but the impression I ended up with was that the ‘capital management’ might involve something other than an increase in the ordinary dividend and the reference to financial risk involved debt levels. I wouldn’t be surprised by a buy-back involving some increase in borrowings. I suppose we’ll find out in due course.

      • Hi Greg Mc,

        I would want to have a serious and very private chat with the board if they choose a buy back at these levels. But not because I don’t think they are below intrinsic value.

      • Yes Roger,

        Think Corporate Express.

        No debt and good cashflow but some fool talked them into levering up

        With reference to a buffet quote I like reading the words ‘financial risk” in the JBH preso about as much as a do preping for a colonoscopy.

        No doubt all will be revealed in the next half yearly report

  37. Great article on QR National. Looks like the Qld gov is offloading a dog – I don’t care about EBITDA I am interested in NPAT/EPS figure, didn’t WB warn about management referring to EBITDA. Are you coming up to Brisbane to do any presentations. I would like to hear you live and get my book signed.

    • Hi Manny,

      I am not sure if I will be in Brisbane anytime soon. Check the events page on my Facebook page. Details will be there. I did make some references to Buffett’s comments about EBITDA here earlier today. Here they are again:

      Here’s Buffett from his 2001 annual letter; “Bad terminology is the enemy of good thinking. When companies or investment professionals use terms such as “EBITDA” and “pro forma,” they want you to unthinkingly accept concepts that are dangerously flawed. (In golf, my score is frequently below par on a pro forma basis: I have firm plans to “restructure” my putting stroke and therefore only count the swings I take before reaching the green.)”

      and this; “After September 11th, training for commercial airlines fell, and today it remains depressed. However, training for business and general aviation, our main activity, is at near-normal levels and should continue to grow. In 2002, we expect to spend $162 million for 27 simulators, a sum far in excess of our annual depreciation charge of $95 million. Those who believe that EBITDA is in any way equivalent to true earnings are welcome to pick up the tab.”

      and this from his 2000 letter to shareholders; “References to EBITDA make us shudder — does management think the tooth fairy pays for capital expenditures? We’re very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something.”

  38. Hi Roger,

    Thanks for the attribution. My point about QR’s EV/EBITDA multiple is important because it highlights the fact QR’s balance sheet will deteriorate as they gear up to buy more locos and wagons and build out the network. To back QR one has to have a higher than usual level of confidence that this capex will produce high incremental returns on capital. We shall see.


    • Delighted Chris,

      The prospectus talks about $170 – $190 million EBITDA run rate on GAPE. After a handful of assumptions I get NPAT of between $60 – $80 million. Given it is entirely debt funded, the circa 6%-8% return on funds employed will only contribute insignificantly to a return on equity figure that has $7.3 billion as its denominator.

      • Ok Roger – so how’d you get that NPAT figure?!

        This is the best I could come up with, and I was hoping you and/or the ‘Quality Quorum’ (Ken, Lloyd, Ashley etc) might point me in the right direction.

        From the offer document, section 8.1, Table 14, pro forma forecast:

        2011 EBIT is 427m and ‘Profit after Income Tax’ 289m. So income tax must have been 138m (427m-289m), and 138m/427m is 32.3% so that seems roughly right given 30% corporate tax. So it seems that ‘Profit after Income Tax’ of 289m is akin to ‘EBI’: earnings before interest?

        I guess my question is what’s the interest worth, and does this hypothesis make sense?

        EBIT = Tax (138m) + NPAT (60-80m) + Interest (?) = 427m, so interest could be circa 209-229m. That’s around 7-8% on 3B debt and fits with Roger’s NPAT. Anywhere near the mark??

        What I don’t understand: did they calculate income tax BEFORE taking into account interest or are they just unhappy to shed light on the debt/interest situation in the offer doc? Isn’t interest tax deductible to a company and therefore needs to be accounted for prior to calculating income tax owed?

        The more I ruminate on this, the more I think I may be painting around the target! Cheers.

    • Hi Mick,

      You are right about Ken an LLoyd and you can add quite a few others as well, but you should not put me in the same company as them.

      I am very lazy, always look for short cuts and no special skills

      The Sixth page of the prospectus is titled “Key Offer Information”

      On that page you will see Proforma 2011 EPS of 11.8c and this is the one I used.

      Interestingly, the page also have number of shares on Issue of 2440m

      So if you take the 289 mill your talk about and divide by the shares on issue you get EPS of 11.8c. So the 289 mill is the net net figure.

      If you really want to know the interst it is on 2011 page 107 of the prospectus( but these look a bit rubbery mind you)

      You are on the right track but the prospectus talks so much about EBITDA and EBIT and proforma profit and statutory profit that is is quite confusing.

      Most people have come up with Equity per share of of $2.78 and this equates to ROE of 4.24%.

      i would think all the Valuable Bloggers Wallets went ZIP right about there

      Given inflation presures are building in Australia I think more money could be made by purchasing frozen peas from woolworths and storing them away for a few years.

      Hope this helps

  39. I got a price of $1.16 for QR. Doesn’t really matter as i am staying as far away as possible from it. Looking at the potential price of $2.80 i would have to say this has T2 all over it. Regardless of any of the IV’s the issue price is stillw ay above it.

    Now i just need to somehow explain to my dad why he should stay away from it as he seems set on it.

    It is a speculation bet at best, you will be buying these shares that somehow hoping in 2 years or so when they can start reducing headcount that they will be able to become more profitable.

      • I bought my father and my brother a copy for their respective birthdays. I’ve been trying to get Dad to flog qantas and telstra for years and he has resisted, but he’s starting to come around, although he’s saying things like “Yeah, but qantas was well over $3 quite recently” as though that means anything. I’ll have to ask him about whether he was planning to have a dip at QR. He made a killing on many of the floats of the past 20 years – CSL, several banks etc. I’m not sure if he’s worked out yet that most of the juiciest floats have already gone and this latest one won’t match CBA or CSL.

    • Hi Andrew,

      You should tell your dad that you have a much better Investment for him.

      Tell him you can give the money to you and your will pay him the equivalant for all the QR dividends too june 2012 plus you will give him back 10% more than the share price of QR on that date.

      This should give you a good float to put all the valuable techniques to work.

      I think you will both be much better off for the exercise.

  40. hi everyone,
    i just listened to an interview with Gerry Harvey from last week, obviously bear in mind that Gerry likes to spruik his own business but he also does like to tell the truth as it is, so take his message with some skepticism…
    anyway, Gerry reckons that the technology retail section is currently suffering, especially the audio visual section such as plasma tvs, laptops etc. he reckons that jbhifi has been a keen competitor in the last few years since this new technology of tvs etc exploded. he thinks though that in the next 5 years jbhifi will not be around unless 2 things happen, they reinvent themselves or some new technology breakthrough happens that unleashes a whole new bunch of new products.
    he says the problem is price deflation that is hurting margins and revenue growth. he also mentions that jbhifi has mainly 3 categories, cds and games – which will be all downloaded through internet in the future, tvs and computers – which will suffer from serious price deflation and margin compression, and finally, a big category for them is they are literally a big Apple reseller – which he says there’s hardly any margins in it.
    so he claims that Harvey Norman will suffer from this as well but the difference is, that for Harvey its only 25% of his business and therefore wont affect him as much.
    i think its something to keep in mind, and maybe why you want to be conservative when forecasting future earnings and intrinsic values.
    I’m sure that new technologies will eventuate and will create new products for us to run out and buy, but than we are placing a lot of hope that some smart developers at Apple,Sony and Google will come up with them!

    watch this space….

    • Thanks for those insights Ron and for sharing with us what one of the wealthiest retailers in the country thinks. I guess if the last two decades has shown us anything it is the rapid speed with which new technologies emerge continuously. I have heard that a very big international telco is looking to raise money (perhaps via a float) to fund the roll out of a satellite alternative to the NBN.

    • Since JBH runs the lowest costs, margin compression will hurt their competitors first, I’d reckon. If those other competitors can’t cut their prices as much, where people going to go?

    • Hi Ron,

      I see Gerry Harvey’s point, however I believe it will still take some years before a majority of people will download all their games and DVD etc. I say this because of my own personal dealings with purchasing the type of products sold by JBH. The reasons why I believe JBH will survive are as follows

      1. I am not a fan of buying on line (perhaps due to my age Early 40, also excludes purchasing VALUE-ABLE)

      2. My kids are too young to purchase these items for themselves and the if the go onto unit etc, they want be able to afford them, so for another 6-8 years I will be visiting the shop.

      3. If i need a hand with how the gidget works works with the widget I go into the shop and ask. I have been in a JBH store approx 6 times, staff know the products and very helpfull.

      4. Shopping in a store can be an outing for the family – include some lunch etc.

      5. It is much guicker to view the stock on hand in the shelves then it is to google it.(for me anyway). Searching online appears to be quick only if you know exactly what you are looking for.

      6. If the game or DVD does not work you take it back and they will swap it, instantly. No waiting in line at the post office to send back a dodgy disc to china.

      7. My apprentice only buys from JBH and so does his friends.

      8. Bought a IPAD Last month, they set everything up for me to use including Pre-paid intenet etc. (You cant get that online)

      I could probably go on, so thanks for your input Ron as it has given me the trigger to re-investigate JBH, and I am currently still glad to be a share holder of JBH

      Perhaps if JBH put a coffee machine in the shop and hired some middle aged staff to create a mix the could cater for ages 10- 50 :)

  41. Hi Roger,

    If I bought JBH for under let say $13.50 then I wouldn’t worry but if you payed $20.00 or so, well. I like JBH but I missed that boat and have jump into another one. A1 is one thing and price is another.


    Fred…………..Thank’s for all your help always, Roger.

  42. HI Roger,
    I think I found the reason for JBH falling; quite simply its technical pullback driven by a falling MACD & low RSI. In other words the market views JBH as any other company and has relegated it ‘range bound’ and is trading it as such. Personally I got out of JBH last summer near the high price & never looked back. cheers Paul.

    • Thanks for your thoughts Paul R.

      An insto broker friend of mine out of London mentioned that his clients were selling retail stocks, “taking money off the table there and going into the resource/China story again”. I concede they do speak a lingo unfamiliar to me.

  43. JBH is one of the most heavily shorted stocks on the ASX, and people fear rising interest rates, slower consumer spending and a strong $AUD will hurt sales, even though tough times usually mean JBH will increase its market share. That being said, we shouldn’t completely ignore sales missing budget by 5%. Funny how the market always seems to price these announcements in before they are made!

  44. David Bebbington

    Hi Roger

    Thank you for your book and its many insights to value investing.

    I am still working through and re-reading vital bits. Your generous nomination of good business A1 A2 possible investing opps have been a huge eyeopener for me. I have not written before as I am very much a novice at investing but the recent GFC has fired me up to perhaps rethink taking more control of my own destiny.

    I look forward to your thoughts in future. Thanks and keep up the wonderful work you do


  45. Hi Roger,

    On the subject of retailers, I like what SFH are doing to improve ROE, profit margin and reducing debt.Where do you rate this business and I would appreciate you IVs as it looks to be undervalued? Thanks for the great work you put into the web site for us all to gain knowledge from.


    • John,
      I hold SFH and believe they are undervalued significantly. Their ROE is very high but dropping over the next couple of years until growth from La Sensa kick in. I still like the company though its price is being beaten down along with other retailers.



    • Hi John and everyone,

      I too was looking at SFH, and I get a rather inviting IV of $3.01. Against the current price of $1.32.


      They have just secured $100 000 000 of new debt from NAB and the rights to a new retail lingerie brand called La Senza with the plan to “rapidly roll out” 100 Stores. I wonder if this removes them from “A’s” entirely and turns them into a B2 or something.

      I am concerned that all that haste, and money to burn, they could very easily erode their ROE and be left with yet another brand, another 100 premises and another 25 mil of inventory.

      I think I will wait and see if they can improve margins in their core business and profitably increase sales by introducing the La Senza brand. If they do, and my caution proves unfounded, then the IV will improve further.

      Scott T

  46. Hi All
    From a sales point of view, I would have thought the 09 (stimulus year) would have put a larger dent in the relative sales figures of JBH, 08 through 2010, that trend combined with my 2011IV being higher than current value. MR Market do your stuff.

    • Thanks Glenn,

      For those of you new to investing and analysing businesses, Glenn is referring to the comparison made between the latest figures and the previous corresponding period (pcp). He’s saying that pcp had the influence of the government stimulus package so for JBH to be beating it, it is still doing a great job.

  47. As a further to your thoughts on JBH Roger, I’d be interested in what you thought of their announcements. Maybe I’m not giving them enough weight but I don’t see a cause for the sell off.

    • Hi MattB,

      There’s tow sides to understanding this. On the one hand there is the fact that market perceives the announcement as a downgrade. Further, it fuels the notion that growth is slowing and there is also the (sometimes misplaced) fear that these things come in threes. On the other hand there is Ben Graham imploring us not to listen to the market. To be conservative you should consider reducing your expected profit numbers by 5-10%.

      • A contributing factor could be general worries about rising interest rates and the value of the dollar hitting all retailers, especially those in the discretionary categories. Market noise, in other words.

    • Hi Matt & Roger,

      Reducing profits by 10% still puts them trading below IV.

      Lets see where Mr Market takes this

      • Gents,

        Judging by your valuations, I assume you are using an RR of 9% ? That seems awfully low to me. I would prefer to use at least 11% for retailers of discretionary products.
        In any event, as an ex retailer, I can tell you that sales below budget in the first quarter is not a good sign, as it puts even more pressure on stores to get their sales numbers up at Christmas. You might think that Christmas is the best time to do that as volumes are up, but so is discounting and increased sales at discounted prices eat into the bottom line.
        Also for what it is worth, they have a new General Manager of merchandise, (who I know), and who has had no previous experience in this field – he came from a grocery background.

        I am not in JBH (because I value them too low), but I would certainly not be jumping into them now, regardless of valuation. Christmas will be make or break for them, and if we get another interest rate rise prior to Christmas, they will be struggling to get their numbers I think.

        FYI & For What it is Worth


      • Very useful insights Ken. Thank you for sharing the JBH information with us. Your comments raise a very queries that are worth putting to the company. Watch for declining ROE.

      • Thanks Ken,

        I am using a different calc but I think it would equate to a 10.5% rr

        That is very good information to know about the newbie running Merchadising section. Thanks for that. I too have some retail experience(nowhere near yours) and know that merchadising is the key component of a retail business.

        Still the business has said that the are cycling very strong comparitive sales figures from last year due to Kevies cash splash and if we all remember last year most retailers had a bad Xmas due to the RBA rapidly raising rates.

        Time will tell Ken and thanks for your thoughts

      • Looks like Mr Market overreacted (of course) this morning with the “5% behind budget” annoucement, some buying came back in the afternoon.
        Now wasn’t this a positive “Gross margin in Australia increased to 22.1%, which was pleasing given the continued growth of lower margin categories and a competitive market place. Consolidated gross margin increased to 21.8% from 21.6% in the prior year. The Company’s cost of doing business was down from 14.7% to 14.5% driven by our low cost culture, operating leverage, labour productivity and marketing economies of scale. The
        Company continues to have the lowest cost of doing business of any listed retailer.”
        The glass half emties were out in force but to me it look as if they are still “continuously improving”
        Efficient Markets Hypothesis – isn’t that a beauty!

    • Take heart in that too much of a good thing is wonderful ! Be greedy when others are fearful and remember that whilst retail stocks are currently out of favor that just means that they have more upside next time round.

  48. good morning all

    Is it just me? I have just read the JBH AGM CEOs report and I cannot see a reason for the price to fall, apart from the 5% behind the sales budget. As far as I can tell the figures still reinforce my 2010 IV of $24.60 and with Xmas arriving (a more critical period I feel). The 2011sales forcast of 3.2bn feeds well into future IV.
    regards glenn

  49. Hi roger,

    Glad to see that your view of QR is similar to mine. I had a value of $0.50 for 2011 and somewhere between $0.80 – $1.00 for 2012. If i remember from a little while back, the Queensland state government is running some severe budget deficits and needs to get some of the monkeys off their backs.

    On to another topic, my IV for Nick Scali (NCK) is in the range $2.00-$2.50 depending on an various scenarios. is your IV similar to that? that would mean the current trading price is at least at 25% discount to its intrinsic value.

    • Hi Thomas,

      Thanks for those thoughts and for taking the time to write. Regarding Nick Scali, I have it trading at a discount to intrinsic value too, but remember you need to consider what the competitive advantage is (if there is one) and that furniture retailing is highly competitive even if the landscape is currently stable.

  50. Hi Roger,

    Speaking of retail stocks, I note that Oroton’s price has also been suffering a little of late. It seems to be at an almost 30% discount to your 2011 valuation (going by your valuation as shown in Tony Featherstone’s article). From what I can work out it is possibly the only A1 stock trading at a substantial discount to its current value.

    My concern is that when I try to value the stock myself I get a number far below the $9 mark (not even in the ballpark). I’m guessing this is because Oroton’s ROE is above 60% but the Value.Able tables only go to 60%. I know this has been touched on briefly by some other readers. Do you think the ROE issue is the likely cause of the valuation difference? And do you think it is worthwhile/sensible calculating a value for ORL using a ROE above 60%? ie. is it sustainable?


    • Hi Steve,

      You raise an excellent point and the reason why the tables in the book only go to 60 per cent. Rates of return on equity above that are usually not sustainable for longer than a few years in Australia because of our small market and especially when low payout ratios are in place. By that I mean companies rarely can continue to retain high proportions of profit and generate returns in excess of 60 per cent.

      • Steve,
        You can easily extend the table for higher ROEs if you wish. Whether that is appropriate or not is up to the individual. For ORL, they could probably maintain ROE above 60% for another 3 or so years if things go to plan – which means (my interpretation anyway) that it is appropriate to use a higher ROE. The growth in intrinsic value before ROE slips below 60% would be significant I imagine.

        As for valuation, I have over $10 using a 10% RR but slightly below $10 if i use a 11% discount rate. So I agree that its trading well below intrinsic value.

        Retailers seem to be on the nose in general at the moment – sentiment is quite negative, many would be nervous about the RBA hiking interest rates over the next few months. These things move in cycles though…if the market becomes confident that interest rates won’t derail the consumer, then retailers including ORL will be back in favour.

        Also not helping the situation is the fact Sally, the Lane Family and other substantials have sold out chunks of their holding – why are insiders selling??
        Maybe Roger has some insights here…this would normally be a clear negative, but these people have considerable wealth tied up in these businesses so who could blame them? I’ve seen plenty of examples where it has no effect at all.

        Hope that helps

      • Hi Ben,

        Thanks for taking the time to share your thoughts about retailers and ORL. I am afraid I don’t have any insights regarding Sally’s sale of shares. Keep in mind that while there are many examples of founders/key people selling shares and share prices subsequently plunging, there are an equal number where the shares continued to rise. Many key people sold their Reject Shop shares into the float. Pull up a chart and see what has happened to its share price since then. Over time the share price will follow the performance of the business.

      • Re Sally McD’s Oroton sales, Ben, you make a good point. She has seen a big price appreciation in her holding to the point where ORL could be the dominant holding for her by a big margin and she may just be spreading her personal risk a little bit. She *may* be just giving herself some insurance against an external shock rather than signalling that the music is about to stop at ORL. One to observe closely all the same and as Ash Little noted, their ROE was down a touch and debt up a bit on their most recent report.

    • Steve Moriarty

      I note today that Sally McDonald sold 150000 of her shares in ORL. She still holds a large parcel, but I think the sale is about 7 or 8% of her holdings. Caveat Emptor!

      • Hi Steve,

        Thanks for the update Steve. Be sure to click ‘refresh’ on your browsers everyone (and clear your cache) when you view this blog, so you can see the latest comments.

  51. Excellent article Roger. I got nervous when the QRN Prospectus only made EBITDA numbers easy to find. It is such a capital intensive business that Depreciation could wipe out any Net Profit to 2012 and possibly beyond.

    I think I’ll pass.

    Scott T

    • So let me get this right Roger:

      The ‘stabilising manager’ has a permit to wear green shoes, and this means they are allowed to buy/sell QRN shares with a view of maintaining the institutional price?!

      It seems like that would certainly act as a safety net for the institutions investment, and perhaps then for other investors for a time, but what happens when they stop ‘supporting’ the price – will we have an institutional selldown/sneakout which leaves the mums & dads holding the empty bucket?

      While I found the QR offer vague, it was actually interesting – and hard to value re dividends, capex etc. I got 92c but skeptical on numbers, in the end I just looked at Equity ps $2.78, figured roughly 5% ROE on EBIT…

      Though I can really see what a capital intensive business means: Depreciation and Amortisation costs were 76% of EBITDA in 2008, 71% 2009, 67% 2010. Some might argue it’s declining and therefore improving, but gee that’s alot of capex to replace/update. Bit like the airlines really!

      • Mick, your ingenious way of looking at depreciation as a percentage of EBITDA is very useful. Well done. Here’s Buffett on the subject: “Our advice: Whenever an investment banker starts talking about EBDIT – or whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditures – zip up your wallet.”

    • mark weber (yes the Local)

      On this QR float I absolutely agree you – better value elsewhere and many less unknowns. Apart from the analytical side of the equation “should I or not” on a more intuitive level the incentives to the dealmakers to successfully float this behemoth are huge at the expense of the people who actually invest in them. I am also encouraged by Charlie Munger–
      ” Any time anybody offers you anything with a big commission and a 200-page prospectus don’t buy it.”

      • Hi Mark ‘the Local’ Weber,

        I hadn’t heard that Munger quote but delighted to have now. Management have some very attractive incentives too. See you this weekend.

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